Chasing the Devil Around the Stump: Securities Regulation, the SEC and the Courts

An Era of Caution

A Challenged SEC Responds

“You have won the O’Hagan case. I hold you exclusively responsible for this great victory by the Commission. You have shown the same great legal skills that you used when you were at our firm and were the cause of our great victory over the Commission in the Dirks case. I hope never to find myself in a position where I have to face your formidable talents in opposition again.”

June 30, 1997 Letter from Milton V. Freeman to Eric Summergrad

A new and unexpected challenge to the SEC’s administrative decision making arose in the early 1990s. The Circuit Court for the District of Columbia, one of the most important courts for handling appeals from administrative agencies, began taking a more activist role against SEC regulations. In numerous decisions, including Business Roundtable ⁶², Teicher v SEC ⁶³, Chamber of Commerce v. SEC ⁶⁴, Goldstein v. SEC ⁶⁵, Financial Planning Association v. SEC ⁶⁶, American Equity Investment Life Insurance Co. v SEC ⁶⁷, and coming full circle to the most recent Business Roundtable case ⁶⁸, the SEC experienced a formidable losing streak.

The courts had traditionally recognized the need for agency flexibility in choosing methods for setting policy, especially where Congress is unable to predict future regulatory needs. The D.C. Circuit Court’s decisions, rebuking the agency over its handling of procedural rule-making, strikes at the heart of one of the SEC’s most significant functions. In light of recent economic upheaval and of Congressional response, the SEC faces increased regulatory burdens in administering the new legislation. The decisions from the D C Circuit Court require yet another adjustment by the SEC in making rules consistent with Congressional intent, managing its litigation strategy, and responding to judicial setbacks.⁶⁹

From 1988 to 2004, the Supreme Court heard only seventeen securities cases, a virtual dearth of decisions compared to the Powell period where it heard almost three cases per term.⁷⁰ The SEC General Counsel’s Office had to make strategic decisions that influenced appellate courts, even where the agency was not a party to the action. The SEC used amicus briefs in cases where the SEC was not a party to the litigation but where they, in collaboration with the Solicitor General’s Office, received permission from the court to file briefs stating the agency’s position. Especially in an era where fewer securities cases were coming to the Court, this practice allowed the SEC to provide advice.

Recent scholarship demonstrates the value of the involvement of the SEC General Counsel’s Office in asserting the SEC’s position, even in cases where the SEC is not a party. The SEC policy is to work with the Solicitor General’s Office to obtain consent to appeal cases or file briefs in cases before the Supreme Court. Since Justice Powell’s departure, in cases where the Solicitor General argued the SEC’s position where the SEC was not a party, the SEC’s view prevailed in over three-fifths of the cases. Even where the SEC filed an amicus brief but did not argue the case, the SEC won nearly half of the time. On the other hand, where the SEC took no position in the case, the court took an expansive view of securities law in only one of eleven cases.⁷¹

The practice of the SEC General Counsel’s Office played an important role in articulating the securities law expertise of the agency. Without a strong securities counterforce on the Supreme Court, such as Justice Powell, the SEC was far more likely to be successful. In choosing carefully which cases it decides to pursue, a lesson the agency learned early in Electric Bond and Share, the SEC continues to be “a pivotal player in the making of securities law” in the courts.⁷²

(62)

905 F. 2d 406 (D.C. Circuit, 1990) which held that the SEC exceeded its statutory authority under the Exchange Act in adopting the one share, one vote rule barring exchanges and NASDAQ from listing common shares with unequal voting rights.

(63)

177 F.3rd 1016 (D.C. Circuit, 1999), which struck down an SEC order barring an individual convicted of securities fraud from becoming an investment advisor because the Court held the agency had exceeded its statutory authority.

(64)

Two cases arose out of the same facts. The first, Chamber of Commerce I, 412 F. 3rd 133 (2005), struck down the SEC’s adoption of corporate governance rules for mutual funds as a violation of the Administrative Procedure Act because the agency failed to consider either the cost of the rules or alternatives to them, and the second, Chamber of Commerce v. SEC II, 443 F. 3rd 890 (1990), which ruled that the SEC again violated the APA by readopting the same rules two weeks after the Court’s prior opinion.

(65)

451 F. 3rd 873 (D.C. Circuit 2006), which held that the SEC’s attempt to regulate hedge fund investors was inconsistent with the Investment Company Act and with the SEC’s own prior interpretations of the Act.

(66)

482 F. 3rd 481 (D.C. Circuit 2007), which held that the SEC rule exempting certain brokers from the Investment Advisors Act was inconsistent with the Act.

(67)

613 F. 3rd 166 (D.C. Circuit 2010), which held that the SEC’s adoption of a rule excluding fixed index annuities from the Securities Act exemption annuity contracts violated the Securities Act because the SEC failed to adequately consider the effects of the rule on efficiency, competition and capital formation.

(68)

Business Roundtable v. SEC, decided July 2011, where the Court struck down the SEC’s adoption of proxy access rules as a violation of the APA because the SEC “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments, contradicted itself; and failed to respond to substantial problems raised by commenters.”

(69)

The Best of NERA 2011, July 26, 2011

(70)

Ibid.

(71)

Ibid.

(72)

Ibid.